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The Future of Central Bank Independence

Central bank independence is under attack. This is true particularly in the United States. When the dust began to settle on the presidential primaries in spring 2016, three of the four leading candidates – one Democrat and two Republicans – supported legislation to audit the Federal Reserve (or Fed) and to compel it to follow a rigid and transparent rule for changing policy in response to changes in a limited range of macroeconomic variables. The reason has a lot to do with the same populist resentment that swirls around global trade. And while the Fed has not received the attention given to the trans-Atlantic Trade and Investment Partnership, for example, it is arguably just as important.

Lawrence Jacobs and Desmond King do great service by explaining why central bank independence has become so unpopular. Their argument centers on perceptions of the links between central banking and big finance. Central bankers tend to come from the financial community, they tend to protect (and may even be ‘captured’ by) the interests of major institutions, and they offer policies with side effects that are injurious to the middle and working classes. This is a subtle argument and not a populist rant. Although the tone of the book is often strident, the analysis shows considerable nuance. Moreover, Jacobs and King are impartial analysts. What they see makes them angry, but they are open to reason.

What Jacobs and King uncover is a fundamental tension buried in the macroeconomic consensus around the virtues of central bank independence. Economists argue that central banks should be politically independent because that is what best serves the public interest. So long as monetary policy remains the purview of experts, monetary policy makers will be able to send credible signals into the marketplace and market participants will be able to use those signals to coordinate their own actions. Over the longer-term, this coordination yields a better trade-off in terms of inflation and unemployment than the alternative of having more ‘political’ control over monetary policy.

The tension in this argument is two-fold. First, it privileges ‘experts’ over politicians. This is a problem because the voters have no obvious way to hold experts to account for their actions. Second, the argument for central bank independence suggests that communication between central banks and market participants is more important than communication between voters and politicians. This seems less like political independence than an attempt to swap one broad group of constituents (called voters) for a much narrower group (called finance). Of course voters may be willing to ignore those points of tension so long as they are rewarded with strong performance in terms of inflation and unemployment. When macroeconomic performance goes disastrously wrong, however, they are less likely to be so supportive.

The challenge for economic policymakers is to confront those two sources of tension. That means they have to hold experts to account and they have to give pride of place to communication between politicians and voters. This does not necessarily entail the elimination of those advantages that were achieved by central bank independence. What it requires is recognition that the days of permissive acceptance of the virtues of central bank independence have ended. Policymakers can choose to recognize that now while they retain some control over the institutions of government or they can wait for pressure to build behind some more radical and populist alternative.